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Ethanol Starting to Trade Like a World Commodity

Date:29-Sep-05Country: BRAZILAuthor: Inae Riveras

Brazilian sugar cane mills say they are getting better deals to sell ethanol fuel abroad by extending what used to be only spot market sales into longer-term contracts with flexible pricing, especially with the rise in world oil prices.

The shift, which is seen as a sign that the fuel is becoming a fully fledged world commodity, is occurring this year across the ethanol export sector, which is on course to repeat the record shipments of more than 2.3 billion liters in 2004.

The recent boom in ethanol use, which is as big within Brazil as it is abroad due to the debut of flex-fuel cars in 2004, has world sugar markets closely watching how much cane may be diverted from sugar production to feed demand for fuel.

Brazil is the world's leading producer and exporter of sugar and ethanol.

"The tendency now is not only to make spot market sales with fixed prices but long-term contracts with indexed pricing formulas," said Philippe Meeus, executive director of Alcotra, a firm that specializes in ethanol trade.

The company is negotiating a three-year contract to ship 90 million liters a year.

"All the sales are moving toward medium- to long-term operations," said a director at a group of cane mills that is also negotiating a three-year contract to ship 40 million liters a year to the European market.

The majority of ethanol export contracts are for one year, although mills are seeking buyers who will sign three-year contracts, traders said.

A longer contract has the advantage of guaranteeing supply, which is crucial to oil majors and countries considering whether to integrate a new fuel into existing energy matrices.

The longer contract also guarantees demand for mills that are seeking cash flow to expand their crop output. Previously, such extended terms were available only through the sugar market, which is also growing but not as fast as ethanol.

"The fixed prices permits investments in logistics. The producer can look for a premium," the mills director said.

MATURING MARKET

Traders say the move toward longer-term contracts is evidence that ethanol is becoming a new international commodity -- like sugar, wheat and oil -- and that high world oil prices are a major factor in bringing about this rare occurrence.

The New York Board of Trade futures contract in ethanol has low liquidity, however, which tends to put off investors who want protection from price swings.

Traders say they are drawing up complex hedging strategies based on New York Board of Trade sugar futures contracts, gasoline futures contracts on the NYMEX and also real-dollar futures contracts.

But traders say their models present difficulties.

"In using the sugar (futures) market you have to think: How many liters of ethanol can I make, if I don't use the cane to make sugar?" said one trader.

"But the two prices don't always run in tandem. A spike in oil prices ends up raising the value of ethanol during harvest," he went on.

Traders said that using the NYBOT ethanol contract, launched in 2004, would be an adequate alternative were it not for the lack of liquidity in the contract.

"The tendency will be that with the expansion of the market, the fixing of (physical) ethanol prices will be done through the New York (contract)," a trader said. "The contract in theory offers the perfect hedge."